Why Some Retirees Won't Get the Full 3.2% Social Security COLA Next Year

Each year, retired Social Security recipients are automatically eligible for a cost-of-living-adjustment (or COLA) to their benefits to compensate for inflation — but not all COLAs are created equal.

Although it was announced in October that Social Security beneficiaries will receive a 3.2% COLA increase next year, most retired federal workers will receive just a 2.2% raise.

COLA calculations for most U.S. retirees are based on the average year-over-year inflation rate in the third quarter (July, August and September) as determined by a measure called the CPI-W. But more than 2 million government employees covered by the Federal Employee Retirement System — a three-tier plan that includes Social Security — typically receive a lower rate than other retirees in years when inflation is high.

Under FERS, retirees only receive the same COLA as Social Security beneficiaries and federal workers who retired under the old Civil Service Retirement System if annual inflation is 2% or less. If inflation is between 2% and 3%, the FERS COLA is fixed at 2%.

And if inflation is greater than 3% — like it is now — the FERS increase is 1% less than the overall COLA.

Sound unfair? Federal labor unions and some lawmakers would likely agree. The American Federation of Government Employees, the largest federal employee union, claims that the difference in calculations for FERS retirees could set them back “thousands or even tens of thousands in retirement benefits.”

“Already, someone who retired under FERS two years ago with an average benefit would have seen their pension fall $440 behind what their yearly benefit should be if it kept up with inflation,” the union wrote in a recent blog post about the "diet COLA."

That’s why unions and proponents of a change to the calculation are pushing for the passage of the Equal COLA Act, which was introduced to Congress in February. Supporters argue that everyone should get the same COLA to create a more just retirement system for all retirees, though critics disagree.

What is the Federal Employee Retirement System (FERS)?

Federal employees are covered by one of two retirement systems: the Civil Service Retirement System or the Federal Employee Retirement System. The CSRS was a public pension fund created in 1920; it provides a lifetime annuity to federal retirees based on their age, average salary and years of service.

The CSRS was replaced by FERS in 1986 due to a series of financial challenges that made the original plan unsustainable in the long term. All federal employees hired after 1986 are automatically covered by the new program, which continues today.

There are only about 100,000 federal employees under CSRS, according to data from the U.S. Office of Personnel Management. Most — over 2 million — are now covered by FERS, which offers a Basic Benefit Plan, Social Security and Thrift Savings Plan similar to a 401(k).

The CSRS applies an annual COLA equal to that of Social Security on federal retirees’ annuity payments, although CSRS retirees do not receive Social Security.

In fact, prior to FERS, federal workers did not receive Social Security at all — Congress designed the replacement program to balance costs by incorporating the employer-matched retirement savings, investment accounts and Social Security benefits.

Employees’ contributions to the Basic Benefit and Social Security tiers of FERS are deducted from every paycheck, and the government pays its part, as well. Under both retirement plans, contributions are used to bankroll the Civil Service Retirement and Disability Fund, which bankrolls benefits for federal retirees the same way the Old Age and Survivors Insurance Trust Fund funds Social Security payments.

Why FERS COLA calculations are different

Supporters of the Equal COLA Act claim FERS COLA calculations set federal retirees back. Rep. Gerry Connolly, D-Va., who introduced the bill earlier this year, said in a February news release that the Equal COLA Act is a necessary measure to enforce parity between the two retirement systems' COLAs.

“This two-tiered system fails to protect FERS retirees who are living on a fixed income,” he said.

But Charles Blahous, a former Social Security trustee and fiscal policy expert for the Mercatus Center at George Mason University, tells Money that it’s crucial to look at the entire FERS package.

It’s true that CSRS gets a bigger COLA than FERS in years when inflation is high, but FERS contributions are much lower than CSRS contributions, he says. FERS participants receive matches for their Thrift Savings Plan contributions that CSRS employees don’t — which Blahous says was the purpose of creating FERS in the first place.

“This is a classic political dynamic: A legislative package is worked out that provides some benefit increases along with some controls on benefit growth,” he says. “Then years later, interest groups come out and demand that the controls be selectively relaxed, as though the other new benefits were never created.”

How increasing COLAs impacts budgets

The Equal COLA Act would require the CSRS and FERS to both institute annual raises tied to the CPI-W, which is used to calculate the overall Social Security COLA. Blahous, however, argues that index overstates actual inflation — and could pose problems if all three systems were based on it.

Increasing the FERS COLA could strain the Civil Service Retirement and Disability Fund and federal budget in the same way that increasing the Social Security COLA would ratchet up pressure on its trust fund. Without additional measures to bolster these funds that pay for federal benefits programs, they could become unsustainable, Blahous says.

This debate comes at the same time that advocates say that not even the Social Security COLA is enough to help older Americans keep up with inflation. Some progressive lawmakers also argue that COLA calculations should change to provide a bigger annual increase on average for retirees by switching to an index called the CPI-E.

Switching to the CPI-E for Social Security COLA calculations would indeed increase benefits in the short term. But, much like an increase to FERS COLAs could have a ripple effect, larger COLAs without a solution to the trust fund's looming insolvency crisis could potentially result in benefits cut down the line.

An August analysis from public policy organization Committee for a Responsible Federal Budget predicts that the funds reserves will run out by 2033 and reduce benefits by $17,400 for the average newly retired, dual-income household. A universal increase to benefits could push the fund toward insolvency even faster, Marc Goldwein, senior vice president and policy director for the nonprofit, previously told Money.

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